'Reading' the balance sheet
What can we surmise from this simple balance sheet (Table 3.8)?
The business has most of its funds and capital employed tied up in fixed assets; these are unlikely to be very 'liquid'. There are relatively small amounts in stock, debtors and creditors and the working capital (net current assets) is a low number. We do not know what the company does and while the individual current asset and current liability numbers are small, if there were problems in selling stock or debtors did not pay, the company might have problems. Maybe the company could borrow more with the fixed assets given as security.
Of invested funds, 5,220 comes from shareholders and 2,355 from borrowing - the company is 2,355/7,575 geared or levered = 31 per cent. This is fairly high, but what is acceptable depends on the nature of the fixed assets and the business sector. Gearing or leverage is considered further in Chapters 7 and 12.
What do balance sheets reveal about a business?
Once again, do remember when interpreting any financial statements that the figures are not the creation of an accountant, but are meant to faithfully represent the business to which they relate.
The balance sheets shown in Table 3.9, with assets and liabilities expressed as percentages of capital employed, are of five different types of business.
TABLE 3.9 Five company balance sheet profiles
Have you any ideas as to what sectors the businesses may be in? Are any obvious? There is one with very high land and buildings and little else; this could be a property company. The business types are:
A) property company that owns and leases buildings;
B) a telecoms utility;
C) a house-building contractor;
D) a multinational with diverse activities;
E) a manufacturer.
Can you now match the profiles 1 to 5 with the types of business? The profiles are of the following types of business:
1 is D, the multinational - a spread of assets and liability amounts.
2 is E, the manufacturer. Numbers 1 and 2 are similar, with a fairly balanced amount of each type of asset or liability. E is more likely to be the manufacturer - it has higher working capital elements, inventory, receivables and payables, which is typical of the sector. Also, land and buildings is a relatively small amount, with more in other fixed assets - plant and equipment.
3 is B, the utility; it has large amounts of other fixed assets - equipment - and high customer receivables with little inventory.
4 is the house-building contractor - work in progress being the key number.
5 is the property-owning company.
Hopefully the above matching appears reasonable, and pretty obvious to most readers - it is obviously easy to do this exercise with knowledge of the answer! The point with interpretation of figures is that information should be used firstly to identify key figures. For example, with the utility, the one asset type which it will have above all others is fixed assets. Looking for large numbers is a sensible first step, but when there are many large figures a way of focusing your decision making is to consider what will be small or non-existent numbers for the business type or sector.